Rosetta Stone’s Recent Acquisition Backfired

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The software industry faced a downturn in 2012 due to the worldwide uncertainties troubling the growth of enterprises. However, Gartner has anticipated that in 2013 the industry will see a rise in its revenues. It has projected a solid growth of 6.4% for the industry. It also expects that this growth will be continued until 2016.

To benefit with this favorable situation, the market players have started expanding their businesses. Rosetta Stone (NYSE: RST), Adobe (NASDAQ: ADBE) and Autodesk (NASDAQ: ADSK) have recently made some acquisitions. In this article, there is a detailed analysis of the future impact of Rosetta Stone’s acquisition on its financial position along with a brief discussion on Adobe and Autodesk’s acquisitions.

What value does the combination bring to the investors?

Rosetta Stone has entered into an agreement to acquire Lexia Learning Systems, a leading education-technology company. Lexia’s products are used in over 14,000 schools and by more than one million students online. This transaction took place for $22.5 million, paid in cash.

The company has planned to strengthen its position in the education sector by making use of advanced technology. The acquisition will add reading technology to its existing portfolio, which will complement Rosetta’s K-12 education business. The acquisition will enable Rosetta to address the changing dynamics of the market and build expertise for learning English with a new collection of solutions.

The acquisition is expected to generate $7 to $8 million of revenue in the remaining five months of the year 2013. The pro forma adjusted negative EBITDA is approximately $1 million to $2 million. The reason for negative EBITDA is Lexia’s investment in its Core5 reading products. The pro forma revenue for Rosetta range from $287 to $298 million, while the pro forma adjusted EBITDA is expected to be between $14 million to $17 million. The pro forma net loss is $3 million and pro forma per share loss is $0.01 to $0.12.

This clearly shows that the acquisition is not going to be beneficial for the company in the near term. However, the management expects that Lexia will contribute positive cash flows within its first full year of operations after acquisition.

Earlier this year, Rosetta Stone also acquired Livemocha, one of the world’s largest online language-learning communities, for $8.5 million in cash. The transaction will expand Rosetta’s geographical outreach in China, South America and Russia. It will advance Rosetta’s transition to cloud-based learning solutions and strengthen its position in the language-learning industry. After these two acquisitions, Rosetta Stone has forecasted its revenue to rise to $400 million or higher by the end of 2015, with an adjusted EBITDA margin of 10%-13%.

Talking about its competitors, Adobe announced its acquisition of Neolane, a market leader in cross-channel campaign management. With this deal, Adobe will improve its marketing cloud offerings. The acquisition is in alignment with Adobe’s strategy to bring more innovations in digital marketing and to provide a complete set of solutions to the marketers. It will complement Adobe’s existing portfolio of analytics, target, social, experience manager and media optimizer. It will also enhance Adobe’s lead in the digital marketing space and broaden its spectrum of offerings to marketing departments.

The transaction is a breakthrough for Adobe. It will enlarge the customer base of Adobe, eventually increasing the profits of the company.

Another peer in the industry, Autodesk, acquired one of its privately held competitors, Tinkercard. The company provides easy-to-use 3D design tools. The acquisition will complement Autodesk’s 123D family and broaden its customer base of apps and supports. Tinkercard’s products are already used as complementary products with Autodesk’s products. Hence, this acquisition will increase Autodesk’s sales.

The company also recently launched a new software; Autodesk FBX Review. The software is used for making a prompt and efficient review of 3D assets and animations. The usage of the 3D technology is rapidly increasing in many fields like gaming, architecture and surgical processes. Moreover, the demand for 3D printers has also skyrocketed. Together these factors will increase the demand for this new software consequently improving the revenue and net earnings for the company.

Conclusion

Rosetta Stone has a weak financial position. The company’s revenue is increasing over time, but due to its higher operating expenses, it has been incurring net losses. It is achieving lower returns on its assets and equity as compared to the industry. Its recent acquisitions will help the company gain a foothold in the US market and expand its business internationally.

However, these acquisitions have brought a negative financial impact on Rosetta. The adjusted EBITDA has declined after the acquisition of Lexia and the company is expected to incur net losses at the end of this year as well. Therefore, I will not recommend this stock be purchased.

On the other hand, the financial position of Adobe is sound. EPS of the company is increasing at an annual rate of greater than 4% over the last three years. Its margins are considerably better than its peers in the industry. The recent acquisition will enhance the core competencies of Adobe. As the future prospects of this stock are bright, I would recommend buying this stock.

Autodesk’s financial position is quite stable. Although its revenue growth is lower than the industry average, its net income growth is significantly higher than its peers due to its high cost control management. The acquisition of Tinkercard is also expected to add positively to the company’s cash flow. The net income is growing at a CAGR of 5.2% over last three years. Its new launch of FBX Review is anticipated to improve its revenue growth and the acquisition of Tinkercard is expected to add positively to the company’s cash flow as well. In the light of Autodesk’s bright outlook, I would recommend buying this stock.

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usman iftikhar has no position in any stocks mentioned. The Motley Fool recommends Adobe Systems and Rosetta Stone. The Motley Fool owns shares of Rosetta Stone. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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